使用警語:中文譯文來源為 Google 翻譯,僅供參考,實際內容請以英文原文為主
David Goode - Chairman, President and CEO
Good morning, ladies and gentlemen.
I'm David Goode, Chairman, President and Chief Executive Officer of Norfolk Southern and I'm pleased to welcome you to our second quarter 2004 analyst meeting.
I welcome the hearty souls that are here on kind of a tough day in New York and we appreciate those of you who came out to be with us.
And I'd like to welcome those also who are listening by telephone conference and those who are otherwise participating on the Internet and, as usual, I remind everybody here to please use the microphones when the time comes so that everybody can hear.
And I also remind our listeners and Internet participants that the slides are available for your convenience on our website in the investor section.
So, if you haven't already gotten to that, we urge you to do so.
As usual, transcripts will be available from our public relations department and also will be posted on our Web site.
Now the lawyers have asked that I remind you that any forward-looking statements made during the course of this presentation represent our best good-faith judgment as to what may occur in the future, actual results may differ materially from those projected, and will depend on a number of variables, some of which may be outside the control of the company.
And I'm asked to refer you to our annual Report and our quarterly Report filed with the SEC for a discussion of those variables.
Let me very quickly introduce those folks from Norfolk Southern who are here today.
As always, we have our Vice Chairman in the front row who will be up later, Hank Wolf, Steve Tobias and Ike Prillaman, also present with us toady are Jim Hixon, our Senior Vice President of Legal and Government Affairs is here on the corner, Kathryn McQuade, Senior Vice President of Finance, over here with Mormon, our Senior Vice President of Corporate Planning and Services is with us somewhere, over here.
And we also have Bob Fort, our Vice President of Public Relations is with us, as is Bill Galanko, our Vice President of Taxation.
Marta Stewart, our Vice President and Controller who I think most of you know and Lee Anne Marilli (ph).
You will note the new last name for Lee Anne McGruder and she'll tell you about it later on if you ask her, Director of Investor Relations, but congratulations Lee Anne.
We're happy to have you with us as always.
And also Debbie Malvin, Hank Wolf's assistant is here in the back of the room if you need anything.
Everybody has made the trip here to be available for questions and I hope you'll take the opportunity to do that.
When we last met in April, I indicated that we were ready for strong performance across the board in the second quarter.
And you've seen the numbers and I am very pleased to report that, that turned out to be so and Norfolk Southern continued to set records again in the second quarter.
Bottom line, our results reflect strong revenue growth and record income from operations with an improved operating ratio.
This is a quarter that was marked by strong operational results for us.
Our board yesterday, you will undoubtedly have noted, increased our dividend by $0.2 or 25%, reflecting the strong improvement in our financial results.
We intend to continue to strive as we have said to you before for continued improvement in our shareholder returns, while at the same time, we paid down debt and improve our balance sheet and Hank will talk more about that in a minute.
Our railway operating revenues for the quarter of $1.8 billion were the highest in our history.
They were up 11%.
We posted our best-ever income from railway operations, that was up 43%.
And our net income of $213 million or $0.54 a share was up 55% year-over-year.
Importantly, we've produced an operating ratio of 76.6%.
That's a 5 percentage-point improvement over last year and 3 percentage points better than last quarter.
So, overall, I don't think there's any getting around the fact that this was a strong quarter for Norfolk Southern.
We were able this quarter to maintain our service levels, our net worth fluidity was good.
We handled some 140,000 more carloads in the quarter, while the cars online remain stable and our other metrics either remain generally stable or improved.
Our Thoroughbred Operating Plan continues to demonstrate its capability of adapting to changing conditions and shifting business demands and our people executed very well in the quarter.
We continue to invest in hiring additional train and engine crews and they're helping Norfolk Southern absorb the strong business growth by consistently executing according to plan.
We continue to benefit from market-based pricing, as our service levels remain high and the demand for our service increases.
Strength is broad and, most important, is driven largely by our core businesses.
In the second quarter, we handle an 8% increase in car loadings with just 4% in additional train starts.
Now that's powerful leverage, as those who follow us know.
Our service quality helped support the 11% increase in revenues in the second quarter.
Simply put, the results you see today reflect our disciplined focus on continuous improvement in service.
At the same time, Norfolk Southern employees improved our already award-winning safety record; our safety results are still leading the industry, and are better in 2004.
Intermodal revenues led our revenue growth.
They grew 21% in the second quarter and 17% for the first half of the year, reflecting growth from truck competitive services, increased business with our trucking partners and strong international shipments.
Coal revenues were up 9% in the second quarter and 11% for the first half.
This growth was driven, in part, by an increased export coal, not only at Lamberts point, but also at Baltimore and further included strong utility demand and better revenue yields.
General merchandise was up 9% in the second quarter, 7% for the first six months that was led by metals and construction and chemicals.
Ike will give you considerable detail on these numbers shortly.
Now while our revenues increased $180 million or 11%, in the second quarter, our expenses were up only $53 million or 4% compared with last year.
As a result, this kind of good leverage, income from railway operations set another new record up $127 million, an increase of 43% in the second quarter.
While fuel costs were up, despite our hedging program, and compensation increased as a result of higher train and engine employment and stock and incentive-based compensation, still we were able to control costs and posted a 76.6% operating ratio in second quarter.
We're also pleased that, that improved over the first quarter, showing consistent improvement.
For the first six months, our railway-operating ratio of 78%, compared with 83.4% for the comparable period last year.
All of you who follow Norfolk Southern on a regular basis know how pleased I am to be able to report that number.
But I'm sure you also know that I think there's still room for improvement, even though the number starts with 7.
We've been watching carefully to see if our record car loadings in the first half of the year continue into July.
So far, there's been considerable traction on that.
As of -- as of yesterday, actually the day before yesterday, I guess, the overall car loadings for the month are up approximately 10% month -- July this year over July last year that's led primarily, again, by Intermodals, metals and coal.
And Norfolk Southern's exceptional second quarter and first half performance have given us one of the best foundations that we've seen in a long time from which to build in this company.
We think our results validate our philosophy of providing higher-value transportation products and operating efficiencies.
As we move forward into peak season, although we believe we've already seen some of the peak and that peak season may not be as dramatic as it used to be, we will continue our commitment to value pricing that reflects the current market value of our rail service, particularly in today's strong market with its demand.
Our people are committed to maintaining and improving our service quality to give us a substantial competitive advantage and an increasingly valuable product going forward.
We don't deny for a minute the difficulty of continuing to provide high service levels in today's transportation environment with surging demand.
But we do believe our plan is showing its strength, improving it quarter after quarter and we have a lot of confidence in it.
In the first half of 2004, we've benefited by handling volume increases with a lesser percentage of train stocks.
So, as I pointed out, that strong leverage, we still have room to add capacity.
Obviously, as business volumes increase, our operating plan will have to be modified to handle the business and additional train starts will be required.
However, we are going to be very careful about our business, to make sure we continue to operate efficiently in order to improve our margins.
We want to grow aggressively and we have room to do so, but we'll be smart about it because we're mindful that our bottom line results still have a lot of improving to do.
As we move into the remainder of the year, I'm very confident that Norfolk Southern will continue its leverage.
We'll continue to leverage our operational momentum, improving service equal and pursuing new business and margin improvement as we do that, reaffirming our position as a thoroughbred of transportation, which is our objective.
Now I'll ask Hank to review our numbers for the second quarter.
Ike will then tell you about the specifics of our market.
Steve does not have prepared remarks, but I'm sure in a quarter like this, he'll be more than happy to talk to you about operations and all that it supports.
We'll take your questions in a minute.
Hank Wolf - Vice Chairman and CFO
Thank you, David.
Good morning.
Let me begin by reminding you that our first quarter results last year included $114 million or $0.29 per share after tax benefit from the cumulative effects of two changes in accounting principles and a $10 million or $0.3 per share after tax gain from discontinued operations related to our 1998 sale of North American Vanlines.
In order to provide you with the most meaningful comparisons this morning, I'll initially exclude these items from my remarks and then reconcile the totals to our reported 2003 results.
As David indicated, we're very pleased with our second quarter results.
The strength that we saw in the economy and talked about earlier has continued.
In the second quarter, we generated record railway operating revenues, which together with moderate increases and expenses, allowed us to produce record income from railway operations this quarter.
As a result of our strong financial performance, our board of directors increased our quarterly dividend by $0.2 per share or 25% from $0.8 to $0.10 per share.
In addition, we have reduced our outstanding debt by more than $300 million in the first half of this year.
Now let me turn to our financial results for the quarter.
Railway operating revenues for the second quarter were a record $1.8 billion, up $180 million or 11%, merchandise revenues increased 81 million.
Intermodal revenues rose 64 million, and coal revenues were up 35 million.
For the first six months, railway-operating revenues were a record 3.5 billion, an increase of 312 million or of 10%, with general merchandise revenues up 130 million, Intermodal revenues increased 103 million and coal revenues rose 79 million.
Second quarter volume increased by more than 139,000 carloads or 8% compared with last year, driven by a 100,000 unit or 17% gain in Intermodal units.
In addition, our revenue per unit increased by 2.8%, resulting in a total increase in revenues of 11%.
For the first six months, carloads were up approximately 248,000 units or 7.3%, largely driven by 170,000 unit or 14% increase in Intermodal volume.
Revenue per unit was up 2.2% and total operating railway revenues improved by 9.8%.
And Ike Prillaman will give you the details of our revenues in just a moment.
Railway operating expenses for the second quarter were 1.4 billion, up 53 million or 4% compared with 2003.
For the first six months, railway operating expense were 2.7 billion, 70 million or 3% higher than 2003.
As you can see from this graphic, the largest increase in railway operating expenses for the second quarter was in compensation of benefits expense.
The increase in compensation of benefits was driven by higher incentive compensation of 19 million, including an increased bonus for locomotive engineers that added 9 million.
Higher stock-based compensation costs of 9 million, reflecting the $4.43 per share increase in our stock price during the quarter.
And higher wage rates that rose 8 million and increased train and engine hours that added another 6 million.
These increases were, in part, offset by reduced non-agreement head counts that saved $7 million and several other items, which collectively, net to 5 million.
The second largest increase in our operating expense in the second quarter was diesel fuel.
As you can see, the average price per gallon of diesel fuel increased from $0.80 in the second quarter of 2003 to $0.86 this year.
Consumption of approximately 124 million gallons was up 6% in the quarter on an 8% increase in traffic volumes.
In the second quarter, we hedged approximately 77% of our diesel fuel requirements.
Those hedges produced $26 million in cost savings by offsetting the purchase cost of diesel fuel.
The third and fourth quarters are 73 and 64% hedged, respectively.
During the second quarter, we hedged almost 96 million gallons of fuel at an average price per gallon of $0.79.
We have approximately 86 and 78 million gallons hedged in the third and fourth quarters respectively.
And the average price per gallon on those hedges is $0.82 in the third quarter and $0.84 in the fourth quarter.
I believe you all are familiar goal of our fuel-hedging strategy -- to reduce the volatility of our diesel fuel expense by averaging fuel prices over an extended period of time.
As you can see from this graph, comparing our average quarterly hedged fuel prices, and the un-hedged price in red, the hedging program has increased the volatility of our diesel fuel expense.
However, with fuel prices near historic high and fuel surcharges being assessed under our recent contracts, we are not currently entering into additional hedges at today's market levels.
Consequently, we're modifying our fuel-hedging strategy on a go-forward basis and our pattern of entering into regular monthly swaps may not be indicative of our future hedging activity.
However, we will continue to advise you of our hedge position for each quarter and the balance of the year on a regular quarterly basis.
Materials, services, and rents increased by 12 million or 3% the second quarter.
That increase was primarily due to an $11 million increase in materials costs, reflecting higher locomotive and freight car maintenance expenses.
Higher volume-related Intermodal purchase services were largely offset by lower equipment rent.
Other expenses were 7 million higher than last year, which benefited from a favorable property tax settlement.
The most significant decline was in casualties and other claims, which was down $9 million or 19%, reflecting lower personal injury expense.
As you may recall, the second quarter of last year included some unfavorable claims development.
For the first six months, railway operating expenses were up 70 million or 3%.
As in the case of the second quarter, the largest increase for the year was in compensation and benefits expense.
In the first six months, we experienced a $49 million or 5% increase in compensation of benefits, compared with 2003, principally as a result of higher wage rates and increased lows for T&E employees that added $27 million.
Increased management incentive compensation and B.L.E. bonus that each added $12 million to our expense.
Increased stock-based compensation of 9 million that I related to you for the second quarter.
And several other items that net to $4 million.
These increases were partially offset by $15 million in savings from our reduced non-agreement workforce.
Materials, services, and rent was the second largest expense increase for the first six months at $17 million, an increase of 2%.
As was the case for the quarter, this increase was driven by higher expenses for materials, principally for locomotive and car repairs, and higher volume-related purchase services driven by our increased Intermodal volumes.
These increases were offset in part by lower equipment rent.
Diesel fuel expense was up $16 million or 8% higher, reflecting a 6% increase in consumption, combined with a small increase in the average price per gallon from $0.83 in 2003 to $0.84 in 2004.
Other expenses were up 11 million or 10%, again reflecting higher property and sales and use taxes this year than we had last year.
Conrail rents and services increased 6 million or 3% because of lower-shared asset costs and casualties and other claims were $20 million lower in the first six months of 2004.
Last year's expenses again were burdened by unfavorable claims development, as well as some higher derailment costs that we experienced in the first quarter of 2003.
The railway-operating ratio for the second quarter was 76.6%, compared with 81.8% last year.
This was our best quarterly operating ratio since the Conrail integration.
For the first six months, the operating ratio was 78%, compared with 83.4% for the same period last year, which was an improvement of nearly 6.5% over last year.
Second quarter income from railway operations was a records 425 million, up 127 million or 43% over the 298 million that we generated last year.
For the first six months, income from railway operations was also a record at 771 million, up 242 million or 46%.
Total other income and expense for the second quarter was an expense of 121 million, compared with an expense of 99 million in 2003.
Gain on sales of property and investments was 5 million, compared with 7 million last year, a decrease of 2 million.
Coal royalties of $11 million were up $1 million over last year.
All other was an expense of 16 million, compared with income of 7 million last year.
The decline was primarily attributable to lower returns on corporate-owned life insurance, which were down $14 million and expenses related to a new investment in synthetic fuel facilities that generate tax credits under section 29 of the internal revenue code.
In May, we announced that we purchased an interest in a limited liability company that owns and operates facilities that produce synthetic fuel from coal.
The members of the L.L.C. are entitled to tax credits under section 29 of the internal revenue code for synthetic fuel produced through the year 2007.
Our investment will result in a pretax expense of our investment, which is reflected in other income net.
But, it will also generate increased tax credit and other tax benefits that are recognized in the provision for us income taxes line.
As you may recall, the net effect of this investment will be to increase our net income and we now estimate that that increase in net income will be $12 million in the year 2004.
Interest expense on debt was 121 million, which was 2 million lower than last year, due to less outstanding debt.
For the first six months, total other income and expense was an expense of 232 million, compared with an expense of 205 million in 2003.
Gain on the sale of property and investments declined from 12 million last year to 6 million this year and coal royalties increased by $1 million.
All other was an expense of 16 million, compared with income of 14 million in 2003, primarily due to the reduced returns and corporate-owned life insurance and the expenses that are reflected for our synthetic fuel facilities investment.
Interest expense on debt for the first six months was 242 million, 8 million lower than last year, due to less outstanding debt.
Second quarter income before income taxes was 304 million, compared with 199 million last year, a 53% increase.
And for the first six months, income before income taxes was 539 million, up 66% compared with 324 million in 2003.
The provision for income taxes for the second quarter was $91 million, compared with 62 million for the second quarter of 2003.
And the effective tax rate for the second quarter was 29.9%, compared with 31.2% last year.
For the first six months, the provision for income taxes was 168 million, compared with 102 million last year and the effective tax rate was 31.2%, compared with 31.5% in 2003.
Our effective tax rate for the full year should be below 30% as a result of our recent investment in a synthetic fuel production facility.
Second quarter net income was 213 million, which is 76 million or 55% higher than the 137 million earned in 2003.
And for the first six months, net income was 371 million compared with 222 million last year, an increase of 149 million or 67%.
This slide highlights the components of the change in net income for the second quarter.
Railway operating revenues increased 180 million, while railway-operating expenses were only 53 million higher.
Other income net increased 24 million, interest expense on debt declined by 2 million and income taxes were $29 million higher, yielding a $76 million increase in net income.
For the first six months, a $312 million increase in revenues was offset by $70 million more in expenses.
Other income net was $35 million lower, interest expense on debt was 8 million lower and the provision for income taxes was $66 million higher.
Combined, these items generated $149 million more in net income.
Diluted earnings per share for the second quarter were $0.54, compared with $0.35 per share last year, a 54% increase.
And for the first six months, diluted earnings per share were $0.94, which is 65% above the $0.57 per share that we earned a year ago.
This slide reconciles the net income and earnings per share for the first six months of 2003, excluding the effect of the accounting changes and income from discontinued operations to our reported 2003 net income of 346 million and earnings per share of $0.89 per share.
This reconciliation is posted on our website.
Net income for the first six months of 2004 was 371 million or $0.94 per share, compared with the reported net income of 346 million or $0.89 per share that we reported last year.
And that included the accounting changes and income from discontinued operations.
I want to thank you for your attention.
Now I'll turn the program over to Ike Prillaman and give you an in depth report on our operating revenues.
Ike Prillaman - Vice Chairman and Chief Marketing Officer
It's bright up here.
Thanks, Hank.
Good morning, everyone.
Manufacturing has had 13 months of expansion that has not occurred since 1999-2000 and, accordingly, the freight market is booming.
As both David and Hank have indicated, second quarter revenue grew 180 million or 11% to a record 1.8 billion with the exception of automotive, all of our business groups achieved record quarterly revenues and as also -- as has been mentioned for the year-to-date, revenue increased to 312 million or 10%.
Volume for the period increased 8% while year-to-date was up 7 and this includes a 17% gain in Intermodal volume for three months and 14% gain for the six months, which our records Intermodal growth exceeded 100,000 loads for the first quarter while merchandise was up 32,000 loads or 5% and coal increased 2%.
Combined, our goal and merchandise volumes for the six months were up 78,000 carloads, which, as a footnote, we're still 95,000 carloads less than the corresponding six months of 2000 and my point being obviously we still have network capacity.
Excluding coke and iron ore, coal volumes increased 3% for the quarter and 4% for the year-to-date.
Strong demand across all the markets drove higher coal production.
Utility volume declined 1% for the period, but was up 1% for the six months.
During the quarter, the large increase in coal being shipped to Georgia Power plants here could not offset the decline of other utility coal markets, which principally were the shipments to the lake as well as some short haul shipments to the river and a lot of that was due to lack of availability.
Inventory stockpiles for the utility, the levels vary, but are generally on the low side.
Higher prices for metallurgical coal, both domestic and export, have caused some diversions away from the utility market.
Export volume for us was up 50% from the quarter and 24% year-to-date, resulting from the increased demand for U.S. met coals.
China has reduced the coke exports and has increased the importing of coal to meet its increasing domestic demand and this has caused the European steel makers to source or at least attempt to source more coal from the U.S.
Global growth in iron production, especially in India and Brazil, and I should add Japanese steel production as well is way up this year, also, along with the significant emerging demand in China for hard coking coals is projected to offset any increased metcoal production in Australia and Canada for the -- so the outlook, we believe, is bullish through 2006 for export volumes.
We are seeing multiple year contracts being signed with certain U.S. producers and one has been signed for up to five years, which is a real sea change in negotiations between the two parties.
Compared to last year, our met coal volumes are up and coke volumes are down due to the continued shortage of coke in the world market and its high price.
The metcoal availability is expected to improve as the Pinnacle Creek mine continues full production towards the end of July.
It had been down for over a year and it has about four million tons of annual production capacity.
But due to the continued shortage and higher prices, I think an indication for the market going forward, we've -- there have been several coke batteries that have been constructed in the U.S. or announced and the market outlook, I believe, for domestic met coal for the future is positive.
And finally, the declines in iron ore volumes were primarily due to reduced production in steel.
Merchandise revenue exceeded 1 billion as the industrial sectors produced solid increases across the board.
As David indicated, metals, construction and chemicals and paper volumes continue to benefit from overall manufacturing expansion and higher production.
Metals and construction lead the merchandise gains with -- revenue growth for the quarter and 10% for year-to-date.
Even with reduced auto production demand, steel remains high.
Low inventories and tight supply are keeping prices up.
Our scrap and finished metals business grew 11,000 Conrail's and, but I would point out again that our demand, this demand or this business level is still 11% below the peak of 2000.
Chemicals revenue was up 13% for the quarter and 9% for the year-to-day.
Plastics and petroleum or refinery products drove the increases with the industry benefiting from improved global demand led by China.
And the paper and forest industry has been experiencing stronger demand.
Our revenue increases in track similarly and I might add that it was this eighth straight quarter that we have experienced year-over-year increases for our paper revenue.
Customers also, on outlook, are indicating strong orders into the second half of 2004.
Ag revenue increased 4% for both the quarters and year-to-date.
The 55% revenue increase in ethanol business more than offset the loss of the drought-related long haul corn business of 2003.
Looking ahead, we expect strong corn volume or grain volumes on NS for the second half as corn planning and production rates are currently running above a 10-year trend and yield is projected to reach - is expected to exceed 10.4 billion bushels and movement of fertilizer was also up with the increased plants.
Automotive revenue increased 252 million for the quarter and 500 million year-to-date, while carloads increased by 1% for both time periods, tracking the 17% to 21% increase in North American vehicle production.
Autocast projects a 2000 model year production of 16.5 million units and that compares with 15.8 million for 2004 model year.
We expect to benefit from the full ramp up of Honda's second assembly plant at Lincoln, Alabama as well as Toyota's expansion at their Princeton, Indiana assembly plant and Ford is bringing two new models on to be produced at their Chicago plant and all of this will be occurring starting in September and going forward.
Serving 39 assembly plants, our automotive franchise, we believe is well positioned for the growth in 2005 and beyond and hopefully our pricing will also continue to improve as we certainly have plans for that.
Diversions from the highways have also added to merchandise revenues.
A shortage of drivers and higher fuel prices created real opportunities in our metals market and construction as well as the paper markets.
Our Intermodal service product continues to attract truckload carriers as customers.
Consistent service performance resulted in highway, the rail diversion for premium truckload business, the domestic IMC's as well as international volume.
Intermodal growth in the US reached 10.6% in the second quarter and this was the highest since 1994.
As previously mentioned, our Intermodal business had both record volume and revenue for any quarter, which happens to be the second quarter and not the traditional third quarter.
Our sustained service and network investments and improved information technology has allowed us to market an overall truck-like product and make NS, we believe, a viable solution for truckload shippers and accordingly, our truckload business was up 34% for the quarter and 29% for the year-to-date.
International business grew 11% and was driven by increased consumer spending and international trade.
I noticed this morning that consumer confidence is at a new high level and some of the volume increases that David mentioned certainly are being driven by that with Intermodal leading the way.
The ship lines are reporting, they are booked to capacity through the end of the year.
There is debate on what specific factors are driving the growth, the Intermodal growth.
Certainly the expanding economy is the primary factor.
However, shortage of drivers, fuel prices, equipment availability and the hours of service law have contributed and I would, again, add along with our service reliability.
Our challenge going forward is to appropriately manage demand, including pricing and capacity.
Looking forward, we anticipate record peak season volumes, which have already been surpassed during the second quarter.
Our revenue going -- looking at the revenue per unit, our revenue increase was a result of favorable changes in revenue per unit as well as volume.
All of our business groups experienced revenue per load improvements for the quarter and year-to-date.
Our Ag, paper, chemicals and coal business reached the highest levels ever and, as you know, revenue per unit can increase because of traffics mixed changes, the long haul versus short haul business or increases due to higher prices or fuel surcharges.
Changes in mix impacted both automotive and Ag's revenue per unit.
The Ag increase occurred in spite of the loss of longer hauled corn business, which was offset by significant increase in the new ethanol business.
Automotive benefited from longer hauls due to an ongoing redesign of our mixing center network and the extension of all of other businesses, this significantly as changed our mix.
As service improved for chemicals, metals and construction and paper revenues -- and we benefited from improved pricing as we continued to price to the market, particularly on truck diversions.
Obviously the large volume growth for metals and construction also changed the market mix.
Intermodal gains resulted from yield improvement and mix, higher-rated trailer volumes increased by 44% for the quarter and 36% for the month.
We are pricing up our domestic transactional business to both market and capacity.
The amount of revenue per unit increase was somewhat tempered by longer-term international contractual business, which is half of our volume.
New traffic mix of short haul business has been developed from the container ship lines, all water service to the east coast and obviously this is placed some downward pressure on the revenue per unit for Intermodal.
Coal's revenue per unit increase is the result of several factors.
Export coal volumes increased while iron ore, coke, and coal shipments to the river have declined.
Mixed changes also impacted revenue per unit as greater volumes moved in longer haul service, such as spot moves of domestic metallurgical coal and increased Georgia powers plant share volume.
Coal traffic, with pricing over $900 increased by 27,000 carloads.
This pricing from new contracts as well as last years rig cases working away through 2004.
To conclude, we are having our best market results since the year 2000.
Our revenues are up $312 million for the first two quarters of year and $407 million over the last three running quarters.
As David pointed out, our July volumes are up approximately 10%, including coal.
Our markets have all performed beyond expectation.
The turnaround outlook for domestic integrated steel production and metallurgical coal is promising.
We believe that our automotive, Ag, Intermodal and utility coal franchises continue to have even more emerging opportunity and we welcome that opportunity and challenge to manage growth and have an the priced market and capacity.
It's a good problem to have.
Thank you.
David Goode - Chairman, President and CEO
Thank you, Ike.
As a company, Norfolk Southern People are committed to continuous and systematic improvement and taking advantages of the opportunity the economy presents us and I think, in a way that's the story of this quarter.
So, I would be happy to take questions.
Yes?
Unidentified Speaker
Thanks, Dave.
I guess my first one really is for Hank on the ending of the fuel surcharge program and kind of your thought process in that because you've said for so long that the whole goal of it was to smooth out the volatility and now it seems like when prices are getting high, are you running for the hills and are you going to grab it if prices continue to go up?
Hank Wolf - Vice Chairman and CFO
Hank never runs for the hills.
Unidentified Speaker
Or and then that the second thing is or have you changed your complete philosophy on fuel surcharges?
And, if you have, what percentage would be pure pricing and what percentage would be from fuel within the quarter?
Thanks.
Hank Wolf - Vice Chairman and CFO
Well, as far as running to the hills, I probably include a parody that my mother told me when I was a small boy and that was he who fights and runs away lives to fight another day.
And I think that just looking at the overall market, what we see happening in the forward curve, what's happening in terms of fuel surcharges being applied to where we can apply, that we believe that a different strategy, rather than the mechanical placing of hedges is a judicious decision to make and that's the decision we've made.
Unidentified Speaker
And then can you talk about the breakdown of that, which is fuel surcharge-related in that 2.8% increase?
Hank Wolf - Vice Chairman and CFO
No, because I would say that that really gets into our pricing and we'd rather not close there.
But where we're able to institute fuel surcharges, we're doing it.
The other railroads are doing it.
The trucking companies are doing it.
It makes sense in this environment and we do have the benefit of some significant hedges that are still in place as I indicated.
We'll report that to you on a quarterly basis, what the numbers that you want to know?
Unidentified Speaker
Percentage of revenues with fuel surcharges?
Hank Wolf - Vice Chairman and CFO
The percentage of --
Unidentified Speaker
Revenues that have fuel surcharges attached to them?
Hank Wolf - Vice Chairman and CFO
I don't think we want to be that specific.
I don't know that it would be helpful, either.
Unidentified Speaker
OK.
And while you're up there, just one quick one.
On the losses that you had in the quarter from the synthetic fuel versus the tax gains, I know you said it was -- I think you gave a number for the year.
Can you talk about the quarter-specific?
Did it offset that negative $16 million contribution?
Hank Wolf - Vice Chairman and CFO
Yes.
What's going to happen is the tax benefits in the bottom line will more than offset the expensing that's taking place in the other income net line, but in the past, there has been smaller transactions where we netted those transactions and there has been a change in -- or transition in the way folks who are accounting for these things and the way the SEC expects us to account for them and that's being reflected in our financial statement.
You're seeing it in a relatively larger transaction or larger investment in this synthetic fuel transaction than we've had in the past.
That's why I say it's safe to assume, with that transaction only being reflected for approximately one month in the second quarter, that you're going to see our effective tax rate for the balance of the year staying under 30%.
Unidentified Speaker
Thanks.
David Goode - Chairman, President and CEO
Pass the microphone and start moving it around.
Unidentified Speaker
We have two different lines of questions here.
First on the Intermodal side, you saw great volume growth.
The yields were accelerating as well.
I'm wondering if you can give me a sense.
Did you see pretty significant expansion of the Intermodal margin or you really hitting the sweet spot on live ranting that network and how much more is there to go in terms of, you know, seeing that Intermodal margin expand significantly as the volumes and yields improve?
David Goode - Chairman, President and CEO
Like volume getting up if you want to amplify.
You saw from Ike's slides the answer is yes.
Those margins are improving and, no, we don't think we've hit the sweet spot in that network yet.
We're going to continue to try to find it.
I think maybe it is a moving sweet spot.
But certainly we are very carefully considering, because there isn't obviously a lot of demand in the Intermodal business.
We have a product that has very high value, and we're going to treat it accordingly.
Steve Tobias - COO
Translating what he attempted to say was finding some of market and capacity, we are being very aggressive.
We have the market, certain pieces of business based on that.
We will remain diligent, but I go back to what our product is with sustained, reliable service it's giving us, this leverage, and where it takes us.
Its all part of the negotiating market process.
As long as we can continue to provide the high levels of service that the customers require, it gives us opportunities, obviously, in the market and we are working very closely with a lot of good partners, in the trucking business it gives us a good opportunity to pursue additional relation ships and help them grow their business.
This is very -- this is really an emerging market still in a way, although it's become very large and important for us.
Unidentified Speaker
OK.
And then I have got one other question for you.
On the capacity side, you saw some great leveraging in the quarter, the 8% unit growth, 4% train starts, at a certain point, does that begin to slow down where, you know, it becomes 8% unit growth and 7% train starts?
Just give me a sense of overall capacity where you see things?
Have you still got a lot of excess capacity?
David Goode - Chairman, President and CEO
I'll ask Steve to amplify that.
As I indicated, we continue to explore what our capacity is, because the more efficiently you run a train network, the better your capacity is in the existing -- with the existing infrastructure and the existing train.
We think that -- we think that we still have room to go.
But naturally, at some point, you have additional trains.
And we're eager to do that and we've done some of that in the quarter and I hope we'll be doing more of it as it goes on.
We think we've got some room to go.
Steve Tobias - COO
I'm not sure I can embellish a great deal more as David.
Clearly we have more gain here, which will produce better utility and more capacity in and of itself.
With that said, in the existing plan that we have in place, we build capacity into it.
We have not yet reached that capacity by several digits yet.
So, in response to your question, there is a great deal more potential here on both sides of that coin.
Unidentified Speaker
In that carload schedule plan, can you give us a rough capacity number?
Are you at 85% utilization in that schedule or, you know, not a specific number, but any rough sense of where we are?
Steve Tobias - COO
Capacity is a very difficult thing to put your finger on.
And I certainly wouldn't want to limit it because there are operational electives that we have at hand to address capacity.
The most prominent example I can give you is remote control or locomotive trains.
Instead of running a train at full capacity, you run a train with additional locomotives and run a train at a half of capacity.
So as we increase our velocity, diminish our load time, there is double-digit improvement on both sides of this from the standpoint of performance and the standpoint of capacity that we have bill into the system.
David Goode - Chairman, President and CEO
We improved the throughput of our hump yards Steve I think 6.17% is this quarter.
Now that's building capacity without touching -- a piece of -- that's just people, systems, and efficiency.
The reason we resist giving you a percentage number on capacity is if we'd done that last year, we would have been wrong.
We discovered we have a lot more capacity than we might have told you last year.
I fully expect that as we continue to -- as we continue to perfect and add systems and we're doing that -- we're doing that quarter after quarter, we're improving our operating systems, and as we do that, we're building train capacity and network capacity.
And we are excited about it and we're eager to see how far we can push that envelope.
Unidentified Speaker
OK, thanks you for the time.
David Goode - Chairman, President and CEO
Why don't you -- is that you, Tommy?
All right.
Next.
You'll get your word in.
Unidentified Speaker
Hi.
Good morning.
David Goode - Chairman, President and CEO
I can barely see people in this light.
I apologize.
Unidentified Speaker
Can you maybe address the potential or the ability you guys had, listening to your term, to gain some share relative to your eastern competitor who might be having more performance-related issues than yourselves?
And then assuming that has been the case, the sustainability of it or the philosophy you have towards it, share a gain on a longer-term basis?
David Goode - Chairman, President and CEO
That is not our business philosophy.
Our business philosophy is to go where the business is and the vast majority of the business is on the highway.
There is an enormous demand for that business right now to move off of the highway on to rail.
That's our opportunity.
That's the opportunity that we are pursuing eagerly and aggressively in marketing and that's the -- that's the philosophy in which we're selling and working.
We work very closely with other railroads in the east as we do with our partners in the west because the best thing for us, actually the best thing for the industry, is to have improved fluidity and efficiency in the entire rail system.
When that -- when that clicks efficiently, then we're really going to see an acceleration in the business because that then speaks to the congestion of the highway, the high fuel costs, all the things you have heard me talk about many times that this produces this demand for our services.
So our principle interest is in doing everything we can to produce an overall efficiently operating rail network and like whomever it was that used to rob banks because that's where the money is.
We're interested in -- we're interested in looking at traffic that otherwise is moving on the highways because that's a huge piece of the pie.
Unidentified Speaker
I guess sort of to that end with the network fluidity, can you maybe comment on the interchange connections and how those may be looking at this point?
David Goode - Chairman, President and CEO
Sure, Steve.
Why don't you do that?
Steve Tobias - COO
I think I answered it at the last session, interchange connections for us are going quite well.
With these kinds of volumes, clearly our interchanges had to be opened.
Now that's not to say that we can't improve.
The industry has launched, in the last five years, major efforts across the gateways of the country to improve our interchange arrangements among ourselves.
We have in place interchange service agreements that stipulate what our format or pro forma is and then we each try to live up to those arrangements and there is a monitoring process that goes on internally within the industry, bilaterally, to ensure that those interchanges are not only maintained, but approved.
So it is not so say that we don't have problems in place, but we're -- we would not be producing the service levels that we're producing today without a consistent -- consistency in our interchange process.
Unidentified Speaker
And just finally, then, Steve, obviously the network is running very well, given the numbers you produced.
Care to venture out what sort of velocity targets you might be looking at?
David Goode - Chairman, President and CEO
We're looking at velocity targets as high as we can get them.
I'll refer to some of the commentary about mix.
Certainly we can't change the laws of physics.
We do, in fact, try to find opportunities maybe to bent it a little.
But if your mix turns more to bulk commodities, it has an impact on velocity.
As we load trains up, if we don't adjust horsepower ratios for time, there tends to be a bit of slowing in the overall velocity, I.E.: Train speed.
There is a balance we try to keep.
Is there a sweet spot?
It maybe we refer to certainly.
But we will continue to try to drive performance from velocity, reduced well turn significant opportunities in the origin terminal to improve overall velocity and consistency.
Our ability to predict connections of traffic flows that impact the service portion of this to the customer is significant and that's one of things that we are driving very arduously now as we're able now with our systems to see the performance on a car-to-car basis, shipment-to-shipment basis, to produce those results.
As the microphone moves back -- go ahead.
Greg Burns - Analyst
Thank you, David.
David Goode - Chairman, President and CEO
Let me -- I was going to point out that interestingly, when you look at the statistics, our train speeds declined slightly towards the end of the quarter.
But our terminal well times improved rather significantly.
Our connection performance numbers improved significantly.
So overall, the efficiency of the network and the effectiveness of the network improved as the quarter went on.
So, be careful to look at the whole picture as you look at these statistics because it has a lot of moving parts.
Greg Burns - Analyst
Thanks, David.
Specifically for -- I have two quick ones for Ike and a broader one probably for you or Hank.
For Ike on Intermodal, just want to know how the hunt relationship is going on and why did the premium -- what is going on with the premium business and why did it only grow 13% when the rest of this grow so much more...
Ike Prillaman - Vice Chairman and Chief Marketing Officer
Only, Greg.
I can't believe I heard you say that.
Greg Burns - Analyst
Never though I would ask a question like that.
And basically for all you guys, right now, you're earning your cost-to-capital, whether you're willing to make a prediction on the year-end whether you're going to.
David Goode - Chairman, President and CEO
I might let Hank respond to the last part of it, Ike.
Our relationship with all of these carriers is good at the moment, I think.
Ike Prillaman - Vice Chairman and Chief Marketing Officer
It is.
And we have a contract that is still in place to get us through '05.
We see no problems after that.
We are negotiating.
We'll start negotiating soon.
As far as the premium business, we somewhat have a mislabeling there as we bring more premium truckload business in and we put it under the caption "truckload" as opposed to premium.
Premium, essentially, is the express package business and obviously it reflects the UPS and downs that U.P.S. chooses between rail and truck and that volume has been fairly even.
But even 9% is not a bad move.
Did you have another --
I think we're thinking of relabeling some of our business because we're -- our philosophy is that our business -- all of our Intermodal business is premium business and we're going to treat it that.
Yes, did you have followup question?
The cost of capital...
[AUDIO GAP]
Hank Wolf - Vice Chairman and CFO
We do.
We talk about it in our company.
Obviously we do not state that we view cost-to-capital or how we calculate cost-to-capital internally.
I would say to you, generally, that the answer is no, we're not earning our cost-to-capital today, but I would remind you that we were one of the few railroads that earned cost-to-capital through most of 1990's and I think we can get that very clearly.
I would also commend you in that question, not only with respect to Norfolk Southern, but with respect to others, to look at the numbers that the SEC produces on return on investments.
In other words, the revenue numbers.
And there is an anomaly on average because the Conrail transactions, if you need to get into that, either Kathryn McQuade or Marta Stewart would be more than happy to help you with that.
That represents a reasonable surrogate to look at overall.
Ike Prillaman - Vice Chairman and Chief Marketing Officer
I think you could take it as an article of faith that our board is looking hard and making sure that not only I, but everybody else in Norfolk Southern, focuses very hard on earning our cost of capital, exceeding our cost of capital, producing economic value added for our shareholders.
We've got objective on that.
We drive them.
We don't publicize them.
We don't talk about it.
You can take it as an article of faith that that is something is very much on the mind of our board of directors and, therefore, on management.
Yes, sir?
Greg Burns - Analyst
David, two quick questions.
One, could you kind of explain your comment about peak shipping season?
Most of the carriers, both trucking and rail, have indicated that they are beginning to see what could be the best peak shipping season since potentially '99 and yet in your comments seem to indicate that you think it will be a little bit less in magnitude...
David Goode - Chairman, President and CEO
What I meant to suggest was that we are -- we are planning very carefully for a peak season and a peak demand.
What we find interesting is, and I've never seen July numbers in the Intermodal business or indeed in business generally like we are seeing today.
I think the economy is strong, but the numbers, we have not seen much -- nearly as much of a decline in July as we have historically seen over my career.
Therefore, we ask ourselves what's going on and we believe that there is some evidence that there is early shipping, there's more consistent shipping and that the peak season, while we do expect a significant run-up as fall goes on, and operationally we're preparing to handle that.
And we expect to be in shape to handle as much business as the peak will bring us.
I'm just suggesting that we believe in some ways the business may have changed.
The peak may be a longer duration and perhaps less peaks and valleys than it used to be and that would be good for the system as a whole if that can happen.
Greg Burns - Analyst
All right.
Sure.
OK.
David Goode - Chairman, President and CEO
We, for example, understand that the ships are full, all the ships have been loaded, that they have been and that they're coming into the ports over the last couple of months full and that the flow of traffic into the ports has been at consistently high levels.
You ask yourself how much higher can it get?
Greg Burns - Analyst
OK.
Already.
Your comments on planning for capacity is a, you know, a good segue to my next question.
This may not be relevant given how well your network is impeaching.
But the chairman Nobers latter told the CEOs about planning for peak shipping and what plans you have in place, your response to him.
Is there any material deviation as to how you're running the network now or...
David Goode - Chairman, President and CEO
No.
We responded to him and we've told the -- in the letter and communications with Ford, we have reported how our planning is going.
It's very much -- it's very much the kind of planning that we always do.
We're trying to work it into our regular planning.
And I don't know if those letters will be -- whether the chairman will choose to post those letters.
Greg Burns - Analyst
OK.
David Goode - Chairman, President and CEO
No particular magic in our response to it, but rather it is a recitation of the way in which we systematically plan to handle the business.
That's what we're doing.
We think we've got it, think we got it now and we're hopeful that the business levels will definitely rise.
Greg Burns - Analyst
And then lastly, on your, you know, hiring plans, you know, a lot of the other rails are struggling with crew shortages and that type of thing.
Can you elaborate a little bit on what's your hiring plans are, especially going into '05?
David Goode - Chairman, President and CEO
As you notice we have more train and engine and other operating employees than we have and you also noticed we have tempered that by reduction in employment in other places.
But we are carefully planning for continued strong and increasing volumes and commands and, Steve, I've forgotten the number of train, the train and engine employees we brought on.
We have 1,300, 1,500, they're in the training pipeline.
We're continuing with that and we're also adding other operating employees that are required to and other employees required to do that.
We are doing what we did last year and you will recall that we were early on that and I was standing before you one year ago today, some of you -- I'm sure not you -- but some of you were beating me up about our compensation line because we had gotten ahead of curve on that.
And we did that, but we planned ahead and we hope that we're continuing to plan accurately and do naturally.
It's a challenge in the shipping targets, we've got it in our sight.
Unidentified Speaker
Hello.
Given your phenomenal quarter, especially on the revenue sides, just wanted to recheck your Capex budget, has that changed?
David Goode - Chairman, President and CEO
No, it hasn't in any meaningful way, we always adjust it a little.
I remind you that we did -- we did announce that we took -- that we were planning a predelivery of locomotives, which we otherwise were taking in 2005.
We have moved that up to both to take advantage of the tax laws and that also will help us with increasing demand as the year goes forward.
So, I just remind you of that change but otherwise, Hank, I don't think there is any -- well, you would have seen that we did announce that we purchased building in Atlanta because for a long time we wanted to move our folks into a better building.
We had an opportunity there and that's not -- that is not an operating item.
It is not a big increase in the budget what we do.
Unidentified Speaker
OK.
And the locomotives that you're purchasing a little bit early are out right purchases, they're not operating leases, OK?
David Goode - Chairman, President and CEO
That's correct.
Unidentified Speaker
And then another quickie, is can you give us an update on your '05 fuel hedging position?
David Goode - Chairman, President and CEO
Hank, do you want to do that?
Hank, just got through, quickly confirming that.
Unidentified Speaker
I have one other question if you want to --
David Goode - Chairman, President and CEO
Go ahead.
You got it?
Go ahead, ask your other question.
Unidentified Speaker
The other question is on export coal.
Our coal analyst seems to think that we, the US, won't start exporting a lot of coal until 2005.
Clearly your numbers indicate differently.
David Goode - Chairman, President and CEO
I would invite our investor's analyst to come to Lambert's Point or Baltimore --
Unidentified Analysts
But I guess my thought is I wonder if there is something to what he's saying in terms of the fact that a lot of it -- his theory is a lot of US coal has already been promised in '04 to domestic utilities.
So, maybe we get an even bigger boost to export coal in '05 or is that just asking for the world kind of we're already seeing such enormous growth rates out of it?
David Goode - Chairman, President and CEO
Are we prepared to speculate on that, Ike?
Ike Prillaman - Vice Chairman and Chief Marketing Officer
Some of your - I could get the line.
On your fuel-hedging question, we're 38% hedged next year based on our projection.
Now obviously that consumption may go up or down a bit and then 4% in 2006 projected so, very little for 2006 and a little under 40% for next year.
Unidentified Speaker
Thanks.
David Goode - Chairman, President and CEO
We prepared to predict the export coal next year?
If you'd done that last year, you would have been wrong for this year.
Hank Wolf - Vice Chairman and CFO
But as I was pointing out there the European steel makers are turning to the US and there will be a question about availability.
Exports were up 50% in the second quarter, which means there were metallurgical coals that were found and we see that and also interestingly are that investment is starting to occur, to bring back mines that used to operate.
We're seeing one produce in Pennsylvania that has been out for over a decade.
So, there's all sources of coal coming in and it's almost a simple formula when it gets up around $104 to $120 a ton on the spot market, the coal is found somehow.
Ike is younger than I, but he and I both grew up in western Virginia and over a few years -- as did Steve Tobias for over a few years, we have learned never underestimate the coal business.
And never give up on it.
Yes, Gary?
How are you?
Unidentified Speaker
How are you?
Ike, one more for you on the export coal business.
If I remember correctly, the -- some of your pricing is tied to the prices of export coal and could you talk to that a little bit?
We're seeing prices in the world market that are absolutely crazy and how might that help your yields going forward?
Ike Prillaman - Vice Chairman and Chief Marketing Officer
Some of that is reflected in the financials and I guess it is publicly known that shipments to the Baltimore facility are attached to price where as the Lambert's point is not.
So, we are starting to see some metallurgical move.
Now the Pennsylvania mines, which I just mentioned, is really unusual in recent history.
We -- you know, the pricing is up because we're, again pricing to market and our prices are essentially insignificant to the price of coal.
Unidentified Speaker
Would you share with us what percent of your export coal is Baltimore or is exposed there?
Ike Prillaman - Vice Chairman and Chief Marketing Officer
In the quarter, probably a 20% to 18% leverage point volume is involved.
Unidentified Speaker
So not that much.
Ike Prillaman - Vice Chairman and Chief Marketing Officer
Not that much.
Baltimore, historically, has been a steam export facility and steam is still -- I mentioned that -- I did mention Baltimore, however, because we are very pleased to see that, volume developing.
That's important for us and it is -- and it is a good deal more than it is here.
Unidentified Speaker
OK.
Thank you.
David Goode - Chairman, President and CEO
Another questions?
I know you're a very patient group and I know that there is somebody else who is going to report shortly if you may have interest in that, any type of questions?
If not, thank you all for coming.
We look forward to see you in next quarter, hopefully with equal or equally good or even better results.
Thank you.